Craig Mitchell, an economist at Nest explains why the master trust has increased its allocation to private markets.
With market difficulties affecting asset classes, one viewpoint is beginning to crystalise across institutional investors – we can’t just rely on public equity to drive strong investment growth.
Expected returns in public markets have been falling putting pressure on schemes trying to meet their investment objectives within an acceptable level of risk.
We are seeing an increasingly concentrated public equity market – the number of listed companies has fallen during the past 10 years. This undermines diversification strategies and should encourage investors to seek out new areas to deploy money.
Whereas private markets continue to demonstrate resilience to external pressures and offer strong growth for our members.
Nest set up private credit mandates in 2019 and our deals have been excellent performers. Even during the pandemic, we did not see a single default on the
loans we issued, reflecting the expertise of our fund managers in their due diligence and loan structuring
.In the past few months, we have added private equity to our portfolio. In fact, our private equity fund manager, Schroders Capital, has already begun to deploy Nest money in a restaurant chain in the US.
Private equity is something we have been considering for quite a while. It’s a prized asset class amongst institutional investors, throughout market cycles, due to a generally persistent high-return premium over publicly listed equity.
Investors can inject capital earlier in the lifecycle of a private company; so-called venture capital (VC). The rewards can be sizable but so are the risks.
VC strategies tend to allocate to a few young companies knowing that while some will fail, only one or two need to be successful to make the investment worthwhile.
There’s no guarantee you will find one of these so-called ‘unicorn’ companies that return 10 times the initial investment – in VC you need to be prepared to
lose some money overall.
We believe deals with companies in their growth phase are best suited to the objectives of defined contribution (DC) pension schemes. These businesses are generating positive revenues but still require the injection of considerable capital to grow and reach their full potential.
These companies often require more than funding. Private equity investors can offer the professionalisation of management and the ability to expand the company, sharing knowledge and expertise.
A concern is how private equity fits within managing ESG risks, but these deals lend themselves to a targeted and enforceable responsible investment policy.
Through private equity, you can have more concentrated influence on companies – in some cases you essentially own them outright and can ensure meeting high ESG standards is an inherent part of the value creation process.
Especially compared to public markets where an investors’ influence is heavily diluted. The general costs and charges in private equity remain high, in part due to the research required to undertake proper due diligence.
Private equity managers generally earn a good profit because investors pay premium fees for the high returns they often generate.
Nest’s arrangement with Schroders utilises a lower cost approach to the asset class by focusing on co-investment deals. While co-investment deals are highly
sought after, often they require an investor to stump up a lot of money at short notice, so managers often don’t get to transact on as many attractive co investment deals as they would like.
We will be providing Schroders with that extra capital so they, and we, do not miss out on closing deals they have undertaken due diligence on.
Undoubtedly private equity can provide strong returns throughout market cycles. For this reason, it has been a mainstay of defined benefit portfolios and in larger DC schemes internationally.
If the right investment strategy is in place, with a repeatable process for finding lucrative opportunities, private equity can help find ‘the winners in the pack’ even in downturns.
We expect these private equity deals to generate superior returns compared to most other asset classes and in the ongoing period of high inflation, private equity should be a great source of investment growth.
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